Look Beyond Europe
06/14/2010 12:01 am EST
Markets around the world have been hit by a wave of selling as nervous investors head for safety. The over-riding concern is the “contagion” spreading from the Greek credit situation.
The collapse of Greece, Spain, and several other countries in the eurozone might put the very existence of the euro at risk. At the least, such a collapse would plunge Europe back into recession. And, of course, that would bring the fragile recovery in America to an end, and the whole world would once more slow down.
Sovereign debt defaults would indeed have serious consequences to the euro and to European economies. While the risk is there, the European Central Bank and the International Monetary Fund have pledged $1 trillion to back-stop European sovereign debt. Nobody has actually written a check for that amount, but it demonstrates the same level of commitment that America took to stem the panic that followed the banking collapse in 2008.
Given the strength of the commitment to support sovereign debt, it seems most likely that defaults will be averted. However, there will be a huge cost: Government debts are ballooning and the constraints being imposed will dampen economic growth. There is no question that Europe and America will continue to muddle along. The chances of a default or other catastrophe are minute, but the economies will grow slowly for some time yet.
Now, let’s look at the other side of the world: Some people are talking about a potential bubble in the Chinese housing market, which might bring down that economy. While prices have risen sharply, and may correct, there is nowhere near as much debt behind the rising prices as there was in America in 2008. The average house in China is funded with 50% equity. The savings rate in China is still very high and consumer debt low.
The popular press is also talking about a slowdown in China. Again, a little objectivity is in order. The Chinese economy grew nearly 12% in the first quarter. The government has stepped in to contain the pace of growth to around 10%.
Fear still permeates the markets. That fear may depress stock prices further. Running for cover to avoid headline-induced fears may provide short-term security, but will not generate meaningful returns.
Those investors willing to look beyond the headlines may note that the latest forecast from the IMF shows the global economy growing at more than 4% this year. Strong growth in the developing world is pulling up the meager pace in the developed world.
It seems clear that investors should avoid investing in the sovereign debt of deeply indebted nations and instead look for opportunities in the developing world. The simplest play on developing economies is resources. Resource-based economies, notably Australia and Canada, are doing well, as mining companies are working flat out to satisfy the growing demands for metals.
Another important theme is that soaring government debts will inevitably lead to further currency devaluations. At this moment, the US dollar is seen as a safe haven. In due course, the huge and rapidly growing debts of the world’s largest debtor will return to the headlines. Over time, gold will continue to benefit from the mounting concerns about the stability of currencies in general.